As recited in seemingly every brief and opinion involving the statute, the False Claims Act traces its history to the Civil War and efforts to deter and punish fraud on the Lincoln administration.  The lure of treble damages, however, has led to aggressive and creative application of the False Claims Act to circumstances far removed from the straightforward fraud perpetrated by unsavory contractors in the 1860s.  One of the most baffling fact patterns recurring in the field arises when relators assert liability based on deviations from a contract that were known to, and sometimes even requested by, federal officials.

For example, a suit arose after officers at the Crane Naval Surface Warfare Center urgently needed two clogged sedimentation ponds to be dredged.  In an effort to expedite the bidding process, the officers directed a contractor to essentially mischaracterize line items.  A would-be subcontractor that failed to land the project then filed a qui tam suit against the government’s contractor, alleging fraud against the United States based on that mischaracterization.  See United States ex rel. Durcholz v. FKW Inc., 189 F.3d 542 (7th Cir. 1999).  One imagines that the contractor did not expect to be accused of fraud against the government based on its compliance with government direction.

Fortunately for the contractor, both the district court and the court of appeals held that the officials’ knowledge barred False Claims Act liability.  189 F.3d at 544-545.  The doctrine underlying those holdings is generally known as the government knowledge defense or government knowledge inference.

The government knowledge defense was codified in the text of the False Claims Act from 1943 to 1986, but was then replaced with the original source rule.  See United States ex rel. Burlbaw v. Orenduff, 548 F.3d 931, 953 & n.20 (10th Cir. 2008).  Following the 1986 amendment, some courts continued to hold that the government’s knowledge of noncompliance by a contractor could rebut the assertion of a knowing presentation of a false claim and could, in at least some circumstances, result in dismissal of a claim as a matter of law.  See, e.g., United States v. Bollinger Shipyards, Inc., 775 F.3d 255, 263 (5th Cir. 2014); United States ex rel. Durcholz v. FKW Inc., 189 F.3d 542, 545-46 (7th Cir. 1999).

Other courts opined that “even the government’s knowledge of a fraud does not necessarily absolve a contractor from liability under the FCA.”  Varljen v. Cleveland Gear Co., Inc., 250 F.3d 426, 429-30 (6th Cir. 2001) (citing United States ex rel. Hagood v. Sonoma County Water Agency, 929 F.2d 1416, 1421 (9th Cir. 1991)).  These courts have, at least in dicta, rejected any defense based on government knowledge.  See, e.g., United States ex rel. Kreindler & Kreindler v. United Technologies Corp., 985 F.2d 1148, 1156 (2d Cir. 1993) (“the statutory basis for an FCA claim is the defendant’s knowledge of the falsity of its claim . . . which is not automatically exonerated by any overlapping knowledge by government officials”).

In the recent Universal Health Services, Inc. v. United States, 136 S. Ct. 1989 (2016), the Supreme Court offered a passing but powerful endorsement of the government knowledge defense.  Focusing on the materiality element instead of the knowing presentation of a false claim, the Court noted that “if the Government pays a particular claim in full despite its actual knowledge that certain requirements were violated, that is very strong evidence that those requirements are not material.”  136 S. Ct. at 2003.  The Court further noted that such a materiality deficit may provide a basis for dismissal as a matter of law.  136 S. Ct. at 2004 n.6.  The Act’s rigorous materiality standard serves as an important limit to maintain what the Court identifies as a relatively narrow scope of liability for government contractors.  Id.

Although Universal Health Services did not focus on the government knowledge defense, it offers compelling reasoning in support of courts that have dismissed False Claims Act suits on the basis of government knowledge.  Contractors can prepare to leverage the relevant passage by committing to transparency with the contracting agencies and regularly advising agencies of compliance and of potential deviations from the initial contract terms.  When agencies request goods or services that may deviate from those terms, prudent contractors will insist on written direction to ensure a solid record for dismissal of any ensuing litigation.  A practice of deliberate transparency throughout performance of the contract can insulate a contractor from significant pain should a False Claims Act suit occur.